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According to a Citibank report, China's foreign-exchange reserves rose sharply in the second quarter of this year by US$178 billion (Bt6 trillion), bringing its international reserves to a staggering $2.13 trillion, the largest in the world. The surge was driven by portfolio inflows and contributed to the recent rally in Chinese stock and property markets.

In addition, China recorded a staggering 34-per-cent year-on-year growth in domestic loans during the period.

Such a flood of double-pronged liquidity will likely lead to greater caution for policy-makers as China risks facing future economic bubbles, especially in terms of asset prices.

Besides trade surplus and foreign direct investment inflows, there were also large portfolio inflows during this year's second quarter due to international investors' growing interest in China, the report said.

While China's trade surplus is narrowing, its exports are showing an improvement as reflected by a large rebound in imports for export-oriented production.

The sharp Q2 rise in foreign-exchange reserves was greater than expected with banks providing 2.8 trillion yuan (Bt14 trillion) in new loans during the period.

The report noted that there remained a number of trade uncertainties, but the general environment demands caution due to the excessively loose monetary policy.

In terms of liquidity, excess accumulation reflects the return of hot money trying to jump on the bandwagon of China's asset markets.

Coupled with China's aggressive loan domestic growth, this return of hot money would drive up asset and consumer prices. China's M1 growth rose further to 25 per cent year on year in June. In addition, there was a 12-per-cent rise in the A-share equity market, which continued through July.

The June CPI report is also expected to show a rise in seasonally adjusted sequential inflation. So all these signs suggest there could be a policy shift soon.

However, the main resistance to policy shift is still trade. In June, the trade surplus narrowed markedly to just $8.2 billion on a $12-billion rebound in imports.

So far, trade volumes have expanded by $18 billion. Such a return to more normal seasonal patterns is encouraging as exports should also be entering their high season.

Moreover, the volume of processing exports and imports have both risen notably, suggesting that the re-export business is picking up, in line with data from Hong Kong and other Asian trading partners.

As a result, growth in China's exports is expected in coming months, even though the year-on-year comparison would still suffer from very high base figures.

Persistent weakness in China's exports has recently led to renewed speculation for depreciation of the Chinese currency, but this is unfounded because capital inflows, improving trade and general economic conditions should allow it to resume appreciation.

Since late last year, the yuan has been depreciating markedly. Nominally, the unit has dropped 5 per cent, while in real terms it has lost 6.7 per cent.

Relative to an average of other Asian currencies, the Chinese unit depreciated by 10 per cent in the second quarter on a real effective basis.